Investors Are Becoming Complacent As Economic Activity Slows
Equity markets put in a solid week with small caps leading the charge as the Russell 2000 notched an advance of +3.2%, the S&P gained +1.5%, the Dow lifted +1.2%, and the Nasdaq tacked on +2.2%. Investors continue to find creative ways to dismiss softening economic data and drama on the political front, while those underweight equities in a rising tape are forced to capitulate and chase prices higher. Ahh, the fear of being left behind and career risk are great motivators to cast aside untimely fundamental views. The cherry on the sundae is a VIX index ending the week below 17, highlighting how complacency and overconfidence have become embedded into investors' psychology after a face-ripping +20% rally.
Look, anyone out there still believing that greed and fear can and do overwhelm fundamentals at any given time in markets need look no further than the fact that the S&P 500 has surged +20% since the lows in April, the Nasdaq & Mag 7 by nearly +30% - yet consensus earning estimates for both 2025 and 2026 have been modestly lowered. Additionally, real interest rates have climbed approximately +20 basis points – remember when the common narrative espoused by the talking heads was that lower interest rates justified rising stock prices because of a lower discount rate. I guess that logic doesn’t work in reverse. Historical data suggest that the forward P/E multiple contracts during such a rise in real yields, but instead we’ve seen it rise by nearly 3 points to just under 22x. While I am attempting to strike a sarcastic tone, the divergence between fundamentals and price is nothing new for a market regime that, at times, is dominated by sentiment, positioning, and headlines.
Nevertheless, a growing number of technical indicators we follow are signaling a stock market that is nearing overbought extremes—not as extreme as the oversold signals near the April lows, but not far off either. The chart below from The Market Ear shows the degree to which investors are chasing performance, with Goldman Sachs Prime Brokerage book seeing the largest 1-week notional buying of U.S. Tech over the past 10 years.
This is the S&P 500’s third foray above 6,000, with the first coming back in November/December and then again at the market peak in late-February – time will tell whether this one has staying power. As I’ve said previously, the path of least resistance for equities in a regime dominated by passive flows and momentum is higher, and that should continue to be the case until an exogenous event or impactful headline hits the tape that causes it to change. At that point, the degree to which prices have outpaced fundamentals is where the gap between the two will matter.
In the bond market, yields on Treasuries are back to testing their nearby highs, despite some disappointing economic data. This shows that inflation concerns, deficit imbalances, and interest rate differentials around the globe are driving the ‘higher for longer’ interest rate environment. Following last week’s jobs report (more on this in a minute) which came as a relief to the market in that the headline +139k print was better than feared the bond market has gone ahead and pushed expectations for the next interest rate cut by the Fed out to September (70% probability was 90% before Fridays jobs report). I know, it's never just one thing, but back in the Fall of 2019, when the Fed cut three times, the 3-month average in job growth was at +172k versus +135k now. So, a slowing in job growth isn’t enough to get the Fed to shift to a more accommodative stance. We’ll have to wait until we get outright weakness, which assures us that the Fed will be reactive, not proactive, to the cycle.
Speaking of the economic cycle, it appears to me that investors are taking comfort in the Atlanta Fed’s +3.8% Q2 GDP growth estimate, but failing to recognize that plunging imports is the major contributor to the headline number, just as rising imports (tariff preordering) were a detractor in Q1. However, when combing through the totality of recent data, it reveals an economy that is losing momentum. The ISM manufacturing survey came out last week with a sub-50 reading for the third consecutive month (as a reminder this is a diffusion index where below 50 denotes contraction, above 50 indicates expansion) while the ISM non-manufacturing survey slipped below 50 (49.9) for the first time since June 2024 and only the fourth sub-50 reading in the last sixty months. Maybe the service sector print is an aberration, but the new order print dropping 5.9 points to 46.6 is indicative of uncertainty, causing at least some moderation in activity.
Beyond that, we have witnessed sequential slowing in construction activity, retail sales volumes, and single-family housing starts. Not to mention, auto sales for May took a big leg lower from what looks like a pre-tariff spending spurt – motor vehicle sales dropped -9.4 % month-over-month to 15.65 million units (annualized) – below the consensus estimate of 16.3 million. If not for the surging stock market propping up boomer retirement portfolios, the asset-light consumer is really struggling. As for the May jobs report released on Friday, it was better than feared, but it cast an unnerving shadow over future reports. Investors focus on the headline print in the initial release and some of the major internals. As long as those don’t contrast too much with expectations going into the report, they digest it and move on.
However, given what has been unraveling with the trend in prior months' revisions, we’re reaching a point where such a philosophy portrays an alternate reality. Let’s go back through all the jobs reports released so far this year:
The initial April jobs report (released first week of May) showed job growth of +177k – consensus was at +138k. So, a big upside surprise relative to expectations at the time, but the April print has now been revised to +147k – pretty close to expectations at the time, and not the big upside surprise initially reported.
As for March, the headline print came in at +228, which was way ahead of expectations for a print around +140k. However, with more complete data coming in over the last several months, job growth in March has been revised to +120k – over 100k lower than the initial headline reading and handily below consensus expectations.
The initial February jobs report showed a gain of +151k vs. consensus estimates of +160k – so pretty close to in line. But February job growth has subsequently been revised down to +102k – well off both the initial print and expectations.
Then we have the January report that came in at +143k, which was below consensus expectations for a print around +175k, but the final tally after revisions shows job growth totaled +111k — 64k below consensus estimates and 32k below the initially reported number.
Two things I take away from this: the headline print is the only thing that really matters to the algorithms, traders, and short-term market sentiment. Additionally, the setup going into the print and where the number comes in relative to expectations is what drives the near-term trend. The other takeaway is that revisions do matter for the medium to long-term economic cycle. Furthermore, revisions are typically procyclical. They tend to trend with the cycle, so positive revisions reinforce the view that a labor market is accelerating, and negative revisions reinforce the view that the labor market is losing momentum. It's clear from the revision data that job growth in the U.S. economy is losing momentum, and this is confirmed by other labor market data like JOLTS, ADP, and jobless claims.
Slowing job growth should not be a surprise given the changes we’ve seen in the labor market over the last ten years (gig economy workers), recent changes in immigration policy, and an economy operating with an unemployment rate at an already historically low 4.2%. Given where we are in the business cycle, you shouldn't expect a vibrantly growing job market. Still, the cumulative downward revisions from January to April totaling -219k (or around -50k per month) is a warning sign. At a minimum, it undermines the ‘economy is accelerating’ narrative but stops short of the “economy is sliding into recession”. We’re in a muddle-through stage of the business cycle, awaiting data that confirms a rate of change acceleration or deceleration from here.
The fact that the S&P 500 is trading near all-time highs is an acknowledgement that things are fine, and the fact that it is trading at a historically rich 22x forward P/E indicates a lot of good already priced in. It’s not difficult to take the other side of this view now, but an investor needs to recognize that he/she need bad things to happen. As for me, I’m back in the ‘indifferent camp’. I don’t see much upside for U.S. equities with the S&P 500 at 6,000, but my work isn’t firing off an abundance of warning signals either. That doesn’t mean I'm not more concerned about the downside risks from here relative to the upside risks, but I’ve also come to understand that is in part my personal bias and an occupational hazard of managing other people's money.
The scales of valuation, sentiment, positioning, and flows are now tipped decisively over into the bull camp. Not excessively, but enough to suggest that there isn’t a lot of meat left on the bone for repositioning in any of these factors to push us much higher. The team over at Data Trek compiled a great chart that tracks State Street’s Institutional Investor Risk Appetite Index, which measures the changes in portfolio positioning, and it shows bullish risk appetite is pushing up against levels that have marked recent near-term tops.
In a nutshell, I don’t think investors should be deluding themselves into thinking that the economy is strong; it's not. Yes, it's stable and resilient, but also know that it is slowing. Some investors look at a stock market that has come raging back from the depths of a 20% correction in early April as confirmation that the economy is strong. Well, beauty is always in the eye of the beholder. Another vantage point suggests that the S&P 500 is neither higher nor lower than where it was almost eight months ago, or that up at +2% ytd, it is performing in line with cash that yields +4% at an annual rate.
Frankly, there are areas outside of the Mag 7 or the S&P 500 that have fared much better this year, and continue to interest me more when considering deploying incremental capital. One area that has come back from the depths at the April lows, but has long been a secular thesis for us, is Nuclear energy. It was encouraging to see last week, Meta Signs Nuclear Power Deal to Fuel Its AI Ambitions, and over the weekend, the FT ran with this: Westinghouse targets $75bn U.S. nuclear expansion after Donald Trump order. A nice shot in the arm for a sector that stands to benefit from growing energy demand due to onshoring, AI, and expanding electrification of the grid in a carbon-friendly way. Though, regarding the nuclear file, we would also note Why Trump’s Nuclear Plans Have So Far Failed to Boost Uranium Prices (many investors are still in “wait and see” mode despite all signs pointing to a jump in demand).
Then you have developments outside the U.S. that already have and should continue to act as a positive tailwind for select foreign equity markets. The German cabinet approved a new package of some €46 billion ($52 billion) in corporate tax breaks over four years, including incentives for electric vehicles and equipment deductions. This is an additional pro-growth measure, funded through regular budget channels, on top of the debt brake workaround fund, contributing over $1 trillion in new defense and infrastructure spending. This sensible policy suite (stimulus and easing) contrasts sharply with the U.S., where a lack of fiscal room means we are getting spending cuts, while the Fed sits on its hands.
India is another market we took an interest in earlier this year, and its economy expanded +7.4% in the latest quarter, beating the consensus estimate of +6.8%, and had a nice sequential acceleration from +6.4% in Q4 of last year and +5.6% in 2024Q3. Even better, on a QoQ seasonally-adjusted basis, real GDP jumped at a +10% annual rate for the second quarter in a row, the most impressive back-to-back showing since coming out of COVID-19 in 2021. This is a capex-led growth backdrop as private business outlays soared at nearly a +20% annual rate and up +9.8% on a YoY basis.
The Sensex is now up more than +5% for the year, among the top Asian performers in 2025. The market there received a major shot in the arm from India’s central bank which cut its key interest rate by -50 basis points on Friday (to 5.5%) and reduced the amount banks must hold in their reserves — in a strong push to infuse liquidity into the banking system (as an aside, the market was only priced for a -25 basis-point rate move). The RBI has now reduced its benchmark rate by -100 basis points over the past three meetings, and the reductions come as the central bank lowered its annual inflation forecast to 3.7% from 4.0% for the fiscal year to March 2026—a bullish setup for a market that receives scant attention.
Not just India, but Brazil’s economy was red-hot to start off the year as well, with a +1.4 QoQ real GDP growth spurt (a +5.7% annualized QoQ seasonally-adjusted bounce) — driven by rising wages via a tightening labor market, which spurred consumption. The Agricultural sector is also booming. That is a super-impressive backdrop given the fact that the central bank has boosted interest rates to their highest level in almost two decades (+400 basis points since September alone to 14.75% and likely more to come), not to mention the rising unpopularity of the Lula government where his disapproval rating has climbed to 56% (beset by many missteps, including the fraud scheme that has been uncovered in Brazil’s National Security System. The Bovespa finished last week with a -0.6% loss, but it is still up a very decent +14% year-to-date
Bottomline, I still like a portfolio of diversified assets with exposure to U.S. and foreign equities, commodities (like select areas in the energy space – nuclear and I’m starting to warm to the oil markets), gold, bitcoin, bonds (both credit and short-intermediate term t-bills) and some cash in money markets that yield 4%. This has been one of the most fruitful years for diversification that I can remember going back to before COVID. For too long, it's been all about the S&P 500 and dominance of the Mag 7. I still think these companies will remain dominant, and investors should have exposure to them, but it no longer must be an all-or-nothing bet.
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